1. Performance evaluation
Primary objective of financial performance
Maximise shareholder value
Shareholder provide funds, assume risks and expect value.
Theories of performance evaluation
The shareholder value perspective
Emphasis profitability over responsibility and sees the organisation as instruments of owners.
Proponents believe that an organisation’s success can be measured by factors such as share price, dividends and economic profit and see shareholder management as a means to an end rather

2. They believe social responsibility is not a matter for organisations and claim society is best served by organisations aiming to achieve self interest which include economic efficiency.
The responsibility of creating employment , improving local communities, protecting the environment, consumer welfare and social developments are not organisational matters but are left to individuals and Government.

3. They believe that paying attention to enlightened self interest and maintaining market- based relationships between the company and all stakeholders, maximising value for shareholders will result in the maximisation of societal wealth.
Measures of financial performance
Profitability is widely used as a measure of the performance of a unit.
However, organisations cannot use profit alone to compare one division to the other divisions (or to compare their performance with their competitors).

4. The reasons are other divisions or alternative investments may have different size or have different operating characteristics.
Return on capital employed (ROCE)
Most popular ratio for measuring general management performance in relation to the capital invested in business.
Roce defines capital invested in the business as total assets less current liabilities which measures profitability in relation to assets.

5. ROCE= earnings before interest and tax(ebit)*100
capital employed(shareholder’ funds +medium and long term debt.
ROCE is influenced by two ratios:
1.Operating profit margin- this illustrates what proportion of sales revenue was retained in the form of profits before deduction of interest and tax.
Operating profit margin=operating profit(ebit)*100
sales revenue
2.Asset turnover Ratio = illustrates how efficiently assets are being used to generate sales.

6. Asset turnover ratio =sales revenue *100
average capital employed
Thus ROCE=operating profit*sales revenue*100
sales revenue average capital emplo
Example
Makano ltd provides the following details. Financial goal of the company for 2013: Roce of 10% minimum. The actual figures are as follows:
EBIT $
Sales revenue $
Average capital employed-----$

7. Previous year’s 2012 ratios were:
Roce %
Operating margin %
Asset turnover -ratio
Calculate ROCE and comment on the results.

8. RETURN ON INVESTMENT
Is the ratio of profit to investment in operating assets.
Normally expressed as a percentage ,the larger the percentage the better the ROI.
ROI is normally used for divisional performance or appraising investment centre performance appraisal.
ROI =return on assets*operating asset turnover
= EBIT * sales
sales operating asset turnover

9. ROI indicates profit earned per $ invested in operating assets of a business
ROIs for successful firms range from 10% to more than 50% although it depends on industry and economic factors facing the particular entity or SBU.
Example
Makomo provides you with information from his two independent projects:
project A project B
Sales
Cost of sales

10. Investment
Calculate ROI and comment.
When using ROI for divisional performance measurement ,in order to achieve better results only capital traceable to the division and controllable by the manager should be taken into consideration.
Thus ROI = divisional profit
division’ capital employed
Advantages
-Versatility (can use, revenues, costs &investment) comparability, flexibility

11. Disadvantage
Ignore time value of money.
Ignore risk associated with the project
Flexibility- results can be manipulated
Inconsistency- income at times taken before interest and tax.
Earnings per share (EPS)
The amount of profits attributable to each ordinary share or what each share has generated in profits.
Saves as an indicator of a company’s profitability

12. EPS = profit attributable to ordinary shareholders
weighed average number of ordinary shares
Example
Makomo gives you the following profit attributable to ordinary shares million
Weighted no/ of ordinary outstanding ,5 million
Industry average $1.5
Previous year’s EPS = $1.7 and the target for current year was $1,9
Calculate EPS for the company

13. Residual Income
Is the operating income that an investment centre is able to earn above a particular minimum return on its assets. Or
It is the net income earned after deducting a charge for the funds invested in the division or investment unit.
RI= income- charge on investment
(charge on investment =investment *desired rate of return)

14. Using example of Makomo investments, assume a rate of return of 5%
Using example of Makomo investments, assume a rate of return of 5%. Calculate RI
Limitations
The major limitations of this method is that because residual income is not expressed as a percentage.
It is not useful for comparing units of significantly different sizes.
If favours larger units that would be expected to have large residual income , even with relatively poor performance.